Buying on the Downside and Selling on the Next Upside

The buyupside.com article Buy on the Upside and Never Buy on the Downside strongly recommends that investors never buy on the downside because most downside buy and sell combinations lose money.

But what results can you achieve if you buy on the downside with the purpose of selling on the next upside? The four most obvious considerations are: the price you paid, how much prices fall from your purchase price, how long you have to wait for the next upside (or how long is the current downside) and how much prices increase on the next upside.

The best-case scenario is that you make lots of money because you bought near or at the bottom of the downside and the next upside is very strong as prices rise significantly. The worst-case scenario is that you lose lots of money because you bought just after the peak, prices bottom at significantly lower values than what you paid and your miserable because the downside lasts a long time. And, finally, the peak of the next upside is much less than your purchase price.

The outcomes for most investors are most likely between these extreme cases. Below are two possible scenarios, money making and money losing, that use a weekly price series for Kulicke & Soffa (KLIC), a cyclical semiconductor equipment maker.

A Money-Making Scenario

The weekly price chart starts with the peak on September 2, 1997 at $27.31. The downside bottoms on October 5, 1998 at $5.78. The peak on the next upside is $41.44 on March 6, 2000 and is the all-time high for KLIC.

The CTM percent return chart shows the 4,144 buy downside and sell next upside trades. Because the peak price of the next upside was much higher than the peak of the previous cycle, 2,926 (70.61%) trades were winners (shown in green). Most of the 1,218 (29.39%) losing trades (shown in red) were bought near the peak or trades that were sold near the low of the next upside.

A Money-Losing Scenario

The next chart shows the weekly closing prices for the downside that started on March 6, 2000 at $41.44 and ended on October 7, 2002 at $2.11. The next upside peaked on November 24, 2003 at $16.44, well below the previous peak.

The CTM percent return chart shows the 7,847 buy downside and sell next upside trades. Because the peak price of the next upside was much less than the peak price of the previous cycle, 6,852 (87.32%) trades lost money (shown in red). Only 995 (12.68%) trades made money (shown in green).

Conclusions and Recommendations

Sometimes the buy downside and sell next upside strategy works and you can make money. But you never know what the future prices will be so you're taking a real gamble that the next upside will be strong enough to lift prices above your purchase price.

Why take the gamble? A more prudent approach is to wait out the downside and buy on the next upside. If you use the Price Direction Indicator (PDI) and the Complete Trading Model (CTM), you'll probably buy at a relatively low price on the upside and set yourself up for a profit as prices rise.

No matter how you try to play the downside, it's a treacherous place to be. So we say again, buy only on the upside and never buy on the downside.